Financial Services VAT exemption blamed for crash

5 October 2011

The Institute for Fiscal Studies claims that the VAT exemption on European Union financial services activities helped to contribute to the recent financial crisis.

Governments, particularly in the UK, came to rely on cyclical income and corporate/business taxes which are vulnerable to downturns in the economic cycle.  By 2008, the percentage take from such taxes in the UK had risen to over 32% - compared to 15% in the 1970's.  The share of total tax take from financial services - banking, insurance and finance - had hit 27%.  When compared to financial services as a percentage of the GDP - about 12% - there was clearly an imbalance in the tax structure and an overreliance on corporation tax from the 'City'.

The conclusion appears to be to diversify from both the reliance on volatile financial services as a share of the economy, but also from cyclical income and business taxes.

The obvious alternative is an increase in consumption taxes - VAT and GST.  These are more consistent in levels over the economic cycle, and do not work against job-creation.

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